In two weeks, the comment period covering the Securities and Exchange Commission’s proposal to reintroduce restrictions around short selling will end. The SEC, as part of a rewrite of Regulation SHO, sought input from the industry, issuers and the general public. Opinions are all over the place, and there is no shortage of handicappers.
On the table are five separate proposals. One involves bringing back Rule 10a-1, or the New York Stock Exchange’s “uptick” rule, rescinded by the SEC in 2007. Another would introduce a price test using the national best bid as the reference price. Three others involve a circuit breaker that would trigger a trading restriction around short sales if a stock’s price declines by a certain amount.
While some in the industry are advocating that the SEC do nothing, far more are betting that the Commission will take action. If so, the choice for the SEC appears to be between a bid test and a circuit breaker that leads to a bid test. The uptick option has been condemned by exchanges and broker-dealers as irrelevant in a fast-paced decimal environment.
The SEC has also said that bids are more accurate reflections of current prices than ticks, which have 90 seconds to print to the tape. Issuers generally advocate the bid test, while the trading industry would settle for a circuit breaker that leads to a bid test.
For the SEC, the issue isn’t easy. The two current Republican commissioners are on record questioning whether any SEC action to curtail short selling is necessary. The SEC’s Office of Economic Analysis, whose data and studies, along with those from outside academics, led to the Commission’s elimination of all price tests for short sales, is believed to be against a change. The SEC staff is also rumored to be against new restrictions.
But the SEC is under pressure from both Capitol Hill and Main Street. Roel Campos, a former SEC commissioner who left the agency in 2007, predicts that the Commission will “probably decide on some version of the price or bid [test], but I don’t know that they’ll choose a circuit breaker.” Campos, now a partner at Cooley Godward Kronish, spoke at a Security Traders Association conference last month. Tom Gira, executive vice president of the Financial Industry Regulatory Authority, said at another conference that a stock-specific circuit breaker that leads to a ban on shorts is the likelier outcome.
Short selling became a fraught, politically charged issue in the wake of last fall’s unprecedented stock market declines. Politicians, the media and investors blamed short sellers for hammering down stock prices. John Nagel, deputy general counsel at Citadel Group, questioned this reaction at an SEC roundtable last month. “The silence is deafening” when it comes to searching for data supporting assertions that short selling was the culprit behind last fall’s market problems, he said. He advised the SEC to “carefully evaluate calls for a price test or circuit breaker in light of empirical data.”
Alfred Berkeley, chairman of equities crossing platform Pipeline Financial Systems and a former president of Nasdaq, described the SEC’s predicament in simple terms: “The short-selling issue occupies the intersection of a circle called market structure and a circle called politics.”
Charles Schwab Corp. and General Electric support a bid test that would operate throughout the day. At the roundtable, both companies said this outcome would help restore investor confidence by stalling rapid declines in stock prices. On the day of the roundtable and the preceding day, more than 1,100 investors also wrote to the SEC, most appealing for new constraints around short selling. SEC commissioners at the roundtable repeatedly asked panelists how investor confidence can be empirically gauged.
Issuers also tend to be down on short selling. In a NYSE Euronext-sponsored survey of corporate executives, conducted last October, 75 percent said short selling should be prohibited when a stock price declines a certain percentage, while 85 percent were in favor of a tick test that would operate during market hours.
Richard Ketchum, CEO of FINRA (who now has SEC Chairman Mary Schapiro’s former job), said he’s had a turnaround on the topic of restrictions. Events last fall changed the game for him. “It continues to be a fact that the world is net long,” he said at the STA conference, but investors’ reactions to big declines in the market are different than those to upward movements. He previously supported the SEC’s repeal of all price tests but said he now supports a circuit breaker that leads to a bid test.
In the trading industry, disagreement about what the SEC should do is rife. Indeed, the Securities Industry and Financial Markets Association hasn’t managed to come to a consensus about the topic. By mid-May the group still had not submitted a comment letter to the SEC advocating a particular position. Many big dealers that have taken funds from the government’s Troubled Asset Relief Program have also remained publicly silent in this discussion. Industry participants say this is largely because they want to avoid the spotlight after having come under severe criticism for their role in the financial crisis.
Credit Suisse doesn’t want any short-selling restrictions, but advocates a circuit breaker that leads to a short-selling ban as the best of the lot, since it would be the easiest and least costly solution for broker-dealers to implement. A bid test with or without a circuit breaker would be equally complex for brokers to implement, said JPMorgan’s Brett Redfearn, global head of liquidity and algorithmic trading. However, he said that a circuit breaker with a modified uptick “is the best way to go.” Justin Schack, an executive at Rosenblatt Securities, argued that the reintroduction of a price test would cause “high-frequency trading participants to curtail their activity by at least 20 percent,” pulling important liquidity out of the market. In his view, a price test triggered by a circuit breaker would be the least harmful among the proposals.
The exchanges are also wary of new restrictions. After a long bout of indecision, NYSE Euronext, Nasdaq OMX and BATS Exchange advocated a bid test triggered by a circuit breaker. The solution they presented to the SEC in March was more stringent than the SEC’s proposal, and was considered easier for exchanges and broker-dealers to implement, but the Commission didn’t include it among its final five proposals.
At the SEC roundtable, Larry Leibowitz, head of U.S. execution and global technology at NYSE Euronext, argued against a circuit breaker-ban combo. “In no circumstance should there be an outright ban on short selling,” he told the SEC. William O’Brien, CEO of Direct Edge ECN, argued against all of the SEC’s proposals. Any price tests, with or without a ban, would be a “significant intervention in the mechanics of trading,” he said.
With all these viewpoints being aired, there were still some surprises at the SEC’s roundtable. Mutual fund giants Invesco and Fidelity Investors unexpectedly urged the SEC to do nothing to restrict short sales. “Immediate SEC action is not warranted,” said Kevin Cronin, global head of equity trading at Invesco. Brian Conroy, head of global trading at Fidelity, added that the best course of action is “for the Commission to not adopt any of the proposals put out for comment.”
Meanwhile, the Security Traders Association, not satisfied with the five options on the table, has suggested a sixth: a circuit breaker that would lead to a “pre-borrow” requirement. This would require short sellers to arrange to borrow shares to settle short sales before executing shorts, once a circuit breaker is tripped. This option, the STA said last month, would eliminate the bigger and deeper problem of naked short selling, in which trades do not settle because the shares were never borrowed in the first place. STA’s message was clear: “Reincarnating discredited regulations isn’t what we need,” said STA chairman Peter Driscoll.
(c) 2009 Traders Magazine and SourceMedia, Inc. All Rights Reserved.
http://www.tradersmagazine.com http://www.sourcemedia.com/
